A follow-up to Japanese monetary policy

News came that the Governor of the Bank of Japan, Kazuo Ueda, had reiterated that further rate hikes are likely to follow as long as the BoJ's outlook is realized. He pointed out that even after the July rate hike, the real interest rate will remain significantly negative, which will continue to support the real economy, Commerzbank’s FX strategist Michael Pfister notes.

Yen is likely to come under depreciation pressure again

“The real interest rate is clearly negative. Comparing this with the rest of the G10, it is clear that the Japanese real interest rate is by far the most negative, ergo the most expansionary. All the other central banks have responded to the inflationary shock of recent years by raising interest rates sharply. Inflation is now falling around the world, so their real interest rates are becoming positive. Only the BoJ is known to have missed the cycle.”

“Japanese inflation is mainly externally driven, i.e. a self-sustaining inflation process has not yet started. From this point of view, there is no need to tighten monetary policy. Nor is growth strong enough to warrant tightening the reins. Japan's GDP has only recently returned to pre-pandemic levels. That makes it the worst performer in the G7. The current real interest rate therefore does not appear to be expansive in a way that sufficiently supports the real economy.”

“In the short term, it does not matter for the yen whether the rate hikes are fundamentally justified or not. Either way, the yen benefits from the interest rate differential, as we saw on Tuesday after the announcement. In the medium term, however, if the BoJ unnecessarily ensures that inflationary pressures fizzle out and at the same time puts pressure on the real economy with a more restrictive monetary policy, the yen is likely to come under depreciation pressure again in the medium term.”

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